RH shares skyrocket, but details about membership program are scant

RH’s design galleries, like the one in Tampa, contributed to second-quarter earnings

RH shares are up over 40% in Thursday trading, the biggest gain ever for the home furnishings retailer, after it reported a second-quarter earnings beat and raised its guidance. But key to the company’s ongoing success will be its membership base, according to UBS analysts, details of which were few in its earnings report.

On the earnings call, Chief Executive Gary Friedman declined to expand on the membership program because there are so few companies besides RH
RH, -3.07%
, Costco Wholesale Corp.
COST, -0.93%
and Amazon.com Inc.
AMZN, -1.70%
who have followed that model. He would only say that renewal rates and membership growth are “positive.”

“[W]e’re the only one that made a move to membership that didn’t start out with membership,” he said, according to a FactSet transcript of the late Wednesday call. “And there’s no benefit in us creating a roadmap for anyone else to follow.”

“It will be critical for RH to drive up memberships in order to sustain this model and not fully revert to a highly promotionally driven sales architecture,” wrote UBS analysts led by Michael Lasser.

UBS says the company has good momentum, but analysts would prefer to see evidence of long-term performance for the long-term.

“We think its membership experiment can have both positive and negative repercussions,” UBS wrote. “While it provides a stable stream of income, it also risks alienating some of its customers who were earlier purchasing smaller ticket items at its stores.”

RH reported adjusted earnings per share of 65 cents, beat the 47-cent FactSet consensus. Sales were $615.3 million, up from $543.4 million last year and ahead of the $606.0 million FactSet consensus. Same-store sales rose 7%.

RH now sees fiscal 2017 adjusted earnings of $70 million to $77 million, up from $60 million to $70 million. The FactSet consensus is for a net income $71 million.

KeyBanc Capital Markets analysts think RH has a positive long-term growth story ahead and is “increasingly positive” about the company after downgrading its stock to sector weight in July. KeyBanc cites strong demand for RH Modern merchandise and good performance of the company’s “design galleries,” its elaborate store locations. There are three more coming in Toronto, New York and Palm Beach.

“The key driver of upside in guidance for the back half is expected to be gross margin expansion of 200-to-400 basis points,” KeyBanc analysts led by Bradley Thomas wrote. “Additionally, management guided full-year cash flow of $400 million, which is well above expectations and is particularly meaningful relative to investor concerns around leverage.”

Analysts also believe short interest, about 50% of the float, supports near-term share strength.

Cowen & Company analysts highlight the company’s supply chain decisions: close one of its distribution centers, bringing the number down to three from four by the fourth quarter, coupled with testing alternatives for “last-mile” home delivery, including using its own trucks and drivers. The company believes it “can dramatically enhance the customer experience while driving down return rates, damages and deliveries per order” with these new capabilities, Friedman said in a statement.

“We agree that vertical integration – while expensive, complex and asset sensitive – is an important part of the long-term journey,” Cowen said. “We would remain on the sidelines as we continue to monitor RH’s transformation and look for better visibility to timing of sales re-acceleration and margin expansion driving positive free cash flow generation in 2017.”

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